Sunday, 26 February 2012

A widely shared synthesis on the symptoms of the global economic crisis exists: unsustainable private and public debt, rapid losses of competitiveness and widening of macroeconomic imbalances within a framework of zero short term interest rates and highly volatile financial markets. These symptoms appear to afflict the whole "West" and are generally identified using as unit of analysis the existing currency areas. A notable exception concerns the euro area: there, the same symptoms, especially in what regards macroeconomic imbalances, are diagnosed to be present in individual countries that form the euro area, but are much less visible when considering the area as a single unit. Although no similarly widely shared synthesis exists on the causes and remedies of these symptoms the proposed policy mix is a multi-year fiscal deleveraging plan accommodated by expansionary unconventional monetary policy and possibly nominal depreciation. (When it comes to the current economic policy debate, I have the feeling that we are watching the latest season of the old Hats versus Caps disputes.)

The last element of this policy mix has been suggested as a solution to the internal imbalances of the euro area: let the euro devaluate and the current account deficit euro countries will readjust by expanding exports in the other currencies areas. I find this view problematic for two reasons. First, it is a currency area membership obligation to accept that internal exchange rates are irrevocably canceled and that the value of the currency changes in the same proportion for each member. Second, as mentioned above, the euro appears to be the only balanced currency area in the World.

Scale 1:1

The second column of the Table (click to enlarge) reports the accumulated current account of the 4 major world currency areas and of oil/gas exporters.

The data show the familiar imbalance between the US and the RoW together with the high government debt of the developed economies. To close this imbalance savings will need to decrease in the ROW and increase in the US, which in turn will require an adjustment of the real exchange rate between the US and the ROW. Notice that the Euro area is much more balanced when it comes to its external position: the Euro area does not participate to the global imbalances. A euro depreciation against the other major currencies would help to improve the external positions of all the euro countries but only if the depreciation increases the euro area trade surplus against the other currency areas. The Euro area is too large and important to act as if it was exogenous to the other currencies areas and must address its internal imbalances in a manner consistent with the adjustment of the global imbalances. The reward for success is likely to be large.

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